Stocks & Commodities V. 26:3 (38-39): The Russell Reconstitution: Plan For 2008 by Don Bright

The Russell Reconstitution: Plan For 2008 by Don Bright

Are there still profit-making opportunities in the Russell 2000? Find out here.

There has been a lot of discussion about the “Russell reconstitution” and whether there would still be a good profit opportunity for professional traders. Some have opined the “edge is gone,” but I am here to say, “No, it isn’t.” I have hundreds of traders, many of whom made excellent money using various strategies, all focusing on this event.

RECONSTITUTION

First off, here’s a basic description of what we’re talking about. Each stock market index is composed of individual stocks. The Dow Jones Industrial Average (DJIA) has only 30 stocks, and the Standard & Poor’s 500 holds 500, obviously. The Russell 2000 is made up of 2,000 small- to mediumcapitalization companies (1,001st through the 3,000th largest domestic stocks as judged by market capitalization). The reconstitution is simply the replacement of certain stocks with others. You have “adds” and “takeouts.” The most recent replacement day was June 22, 2007.

The reasoning behind the concern about making profits was based on the fact that the stocks being swapped are known well in advance of the actual event. This is not the case with the S&P 500 (they use a closed approach). This knowledge leads to what is referred to as “front-running” — buying the adds and shorting the takeouts ahead of the event. Bright Trading had traders who did, in fact, begin their trading weeks ahead of the June 22nd date. Our people tended to close most positions ahead of June 22 profitably and then take a clean slate for the actual event. Simply knowing the new composition of stocks ahead of time is not enough to guarantee profits (“guarantee” is a tough word to use in this business anyway), but when combined with some market savvy, access to enough capital (via professional capital-use capabilities), our traders did very well.